46 – Holiday Homes Make Poor Investments

We spent last weekend five hours South of Perth in Albany, WA. With the kids in tow, we rented a cutesy old cottage for they duration so they’d have their own rooms and space to run around.

Being away in this context soon got me thinking about the many reasons why we veered away from holiday homes/apartments as an investment. With family frequently visiting from intrastate and overseas, a property that could be rented out is when not in use was hugely appealing to us at first glance but many reasons led us to reconsider.

When we first started looking seriously at property investment, one of my first thoughts was to purchase a holiday apartment. I figured something with a few bedrooms in nearby Scarborough might not cost too much and “Scarbs” is an increasingly vibrant area in Perth. It’s also a good spot for visiting tourists with its expansive beaches and nearby amenities. I’ll note this was before I came to prefer land (i.e. a house on a block of land) over apartments and decided to invest for long-term growth rather than cash flow—in short, don’t buy an apartment because the land content ratio is too low…). In general, you’ll likely pay a premium to buy in a holiday location—which may not relate to long-term capital growth. In other words, are you better off buying into a highly-priced holiday location or doing your research to buy into a cheaper suburb that’s likely to grow faster and produce a better return on investment in the long run?

We also had to ask ourselves whether we buy something local for the sake of the visiting relies or choose something further afield in a more interesting (to us) location—either out of town or in another state. If we wanted to make use of the property ourselves, would a “holiday at home” (er, a property in Perth, where we live) be all that desirable?

Regardless of location, the ability to produce an income will always be at the mercy of the local short-term rental market and tourism conditions. Although I’m no expert in this area, I’ll hazard a guess that sites like Air BnB are eating into the traditional short stay markets.

With a normal rental, you have the surety (in a way) of a guaranteed weekly rent for the term of the lease. With a holiday home, you might have a higher nightly rate but the uncertainty of whether the property will be full one night and vacant the next—which, on average, may or may not equate to the same income as a regular rental. Averages are useful but may hide seasonal ups and downs and corresponding cash flow troughs throughout the financial year.

Unlike a typical suburban house rental where we’re renting a property to a tenant as a place to live, as their home, with a holiday home we’re dealing with a different set of variables. How closely are holiday makers vetted? How do we insure the property? Will neighbours object to the comings and goings of visitors at unusual hours? What happens if China crashes and the Chinese tourists suddenly dry up? We had a global recession not all that long ago; are the Yanks still flying in to little old Perth at the same rate they were before the dot com and housing market crashes?

At the very least, you’ll need to estimate vacancy, affix a nightly rental price tag that fits the market and attracts the right kind of holiday makers or travellers, and then consider marketing costs (for your online listing, membership with the local tourism body or visitor centre, etc) and cleaning costs. Of course the property will also need to be furnished with not only furniture and appliances but linens, cookware, books/DVDs, artwork, etc. Other running costs will include electricity, water, gardening, and possibly cable and internet, as well as the usual rates and insurances.

Don’t forget, if you want to use the property yourself, the ATO will require you to exclude the period when the property was not available for rent as a percentage of any deductions you might want to claim (i.e. negative gearing). On the upside, you may be able to claim a higher rate of depreciation (4% p.a. over 25 years instead of 2.5% p.a. over 40 years).

If you want to use the property yourself during peak periods, then you’ll likely have to forego any income the property would otherwise generate during that time.

The property we rented in Albany, although lovely in an historic kind of way and very practical for our young family, has zero appeal to me from a practical and maintenance standpoint. Although the main house felt sturdy and sound, the back extension (these places always have a back extension, right?!?) had a definite lilt to it despite being the newer construction.

Then my wife plugged in the kettle for her morning tea but it wouldn’t switch on because she’d unwittingly tripped the circuit. Of course we just thought the kettle was a dud—until it came time for a shower and we had no hot water from the instant gas system with its electric ignition. It took a very upset wife and a call to the neighbouring manager, at 8:30am on a Sunday morning, to sort that one out.

We’ve been living in a relatively new house in Perth for going on a decade now and although it’s been a pretty easy run there are always things to deal with—we’ve already had to replace the hot water tank, for example. I cannot begin to imagine the countless number of ongoing issues to be found with an older house. On the one hand, it’s established and “bedded in” but how soon until the roof needs replacing or the foundation restumping? Insects and damp or mould may be problematic in older houses and the electrics may be shady.

Although I’d love to have a nearby holiday home for the relatives or a beach shack down south that we can use periodically, as an investment we’ll be sticking with suburban houses for now and fork out for a week or two in that holiday rental when we want to get away.

I suppose a disclaimer is also worth posting: I'm just a guy, I'm not an accountant, lawyer, solicitor, tax agent, mortgage broker, banker, financial adviser, insurance agent, land developer, builder, government agent, or anything else so I disclaim your application of anything I write here is to be applied at your own risk. What I write may be incorrect and you are best to seek your own professional advice (tax, legal, financial, and otherwise) before entering into contracts or spending your money. Your situation is unique to you and what I write here reflects my experience only. This content is not professional advice and is not tailored to your situation. I’m not selling anything and I do not receive any form of commission or incentive payments for any companies or individuals I endorse. I'm learning too and expect to make many, many mistakes along the way.

Enjoy,

Michael

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